Inbound Marketing & Sales Development Inspiration
Originally published September 2016.UpdatedJan 2019 with lifetime value example.
When you spend $1 on marketing, how much should you expect in return?
When someone asks you, is your marketing working, what do you think theyre really asking? Are they asking if its generating awareness, generating foot traffic, or generating sales?
When I ask this question, I want to know if your marketing is effectively generating business in a profitable way. Thats really what marketing is trying to accomplish, after all.
Anyone responsible for spending money to generate revenue (e.g. marketers) should have a simple way to know if their activity is generating business. This is why return-on-investment (ROI) is such an important metric for any business activity.
ROI is calculated using two primary metrics: the cost to do something, and the outcomes generated as a result (typically measured in profit, but for this discussion, lets use revenue).
There are a few challenges with calculating ROI for marketing activities.
For one, calculating ROI for marketing can be tricky, depending on how you measure impact and costs. Large corporates have complex formulas and algorithms which factor dozens of different variables.
Secondly, calculating ROI manually for each marketing campaigns takes time and access to company financials.
Thirdly, this approach requires patience. It could be months before knowing if a campaign was profitable.
In a nutshell, calculating marketing ROI the traditional way isnt always practical. We need a better method.
So lets shelve the complex formulas and algorithms and focus on one simple metric: the revenue to marketing cost ratio.
The revenue to marketing cost ratio represents how much money is generated for every dollar spent in marketing. For example, five dollars in sales for every one dollar spent in marketing yields a 5:1 ratio of revenue to cost.
A 5:1 ratiois middle of the bell curve. A ratio over 5:1 is considered strong for most businesses, and a 10:1 ratio is exceptional. Achieving a ratio higher than 10:1 ratio is possible, but it shouldnt be the expectation.
Your target ratio is largely dependent on your cost structure and will vary depending on your industry.
Ratios are easy to understand and easy to apply. Before any marketing activity is started, everyone understands what it needs to generate to be successful.
Also, as long as the right tracking mechanisms are in place, everyone can quickly determine if a campaign was successful or not.
When calculating your ratio, a marketing cost is any incremental cost incurred to execute that campaign (i.e. the variable costs). This includes:
Because full-time marketing personnel costs are fixed, they are NOT factored into this ratio.
The ratio is meant to give campaigns a simple pass/fail test, so the costs factored into the ratio should only occur if the campaign runs.
At an absolute minimum, you must cover the cost of making the product and the cost to market it.
A 2:1 revenue to marketing cost ratio wouldnt be profitable for many businesses, as the cost to produce or acquire the item being sold (also known as cost-of-goods-sold, or COGS) is about 50% of the sale price. For these businesses, if you spend $100 in marketing to generate $200 in sales, and it costs $100just to acquire the product being sold, you are breaking even. If all you accomplish with your marketing is break even, you might as well not do it.
Companies with higher gross margins (their COGS are LESS than 50% of the sales price) dont need to achieve as many sales from their marketing before they become profitable. Therefore, their ratio is lower.
Meanwhile, companies with lower margins (their COGS is MORE than 50% the sales price) need to stretch their marketing dollars further before it becomes worth doing. Their ratio would have to be higher.
Resource:Cross selling onlinecan help increase customer lifetime value, which lowers your cost-per-acquisition goal.
Lifetime value refers to the value a customer brings a business over their entirelife as a customer, NOT just through their first transaction with you. Manybusinessesonly think in terms of first transaction valueand call it a day. Butthe customerlife can be far more fruitful than that,so to accurately calculate return on investment, we need to understand the full return.
For example, we worked with one client to set up a tracking a reporting system for the paid search campaign (PPC). Previously, we would onlyattribute the first salegenerated from a PPC click back to the campaign. In reality,these customers would come back several times, usually from other channels, to make additional purchases.Since that customer came from the PPC campaign,PPC should continue to get credit for incremental sales made.
Remember that chart at the beginning of this post showing $500k in revenue on $112k spend? This client had achieved the 5:1 revenue to spend ratio, but thats not the whole story. Prior to adding repeat purchases to this chart, the return on PPC looked a lot different. And it wasnt pretty.
When we onlycounted first sale revenue from PPC and not lifetime value, we werent even achieving a 2:1 ratio.
And heres how the cumulative difference between first sale value and lifetime value looks over time.
The spend never changed, but our perception of the campaigns impact on revenue (and ultimately ROI) changed dramatically.
How Do I Calculate My Target Marketing ROI Ratio?
A CMO, CFO, or CEO will be able to calculate your target ratio. They will factor in the companys gross margin targets, overhead expenses, and what it takes for money to hit the bottom line (the ultimate goal).
Keep in mind that achieving a 10:1 ratio every time is unrealistic, and shouldnt be the expectation for your marketing campaigns. For most businesses, a 5:1 ratio will be the target, and anything beyond that is gravy.
It is not easy to calculate revenue generated for all marketing activity. Certain tactics like social media, content marketing, video, and display ads target users long before a purchase takes place.
Marketing software platforms such as Hubspot, Marketo, and Pardot do a good job of connecting early engagement to a final sale, but they are not perfect.
Just because a marketing activity cant be measured perfectly, it doesnt mean it shouldnt be considered.
That being said, marketers should always work to connect the dots between activity and revenue.Advances in web analytics software and methodology provide better insight for measuring activity over time and across different devices.
Finally, marketing is about generating revenue. Its not about art, humor, or creativity.
Marketers who arent serious about tying their activity back to revenue are missing the bigger picture.
Implementing a ratio, and treating it as the golden metric for marketing activity, will focus the team on the ultimate outcome:growing the business.
Every $1 spent on marketing campaigns should yield approximately $5 in revenue. This will vary depending on the economics and COGS of your particular business.
How Much Should You Budget for Marketing in 2018?
As President, Chris is responsible for leading all the day-to-day operations of WebStrategies. His work has been featured on the Google Analytics and Hubspot blogs, and hes a regular columnist forthe Richmond Times Dispatch.